Leone v. Owsley

FILED
United States Court of Appeals
Tenth Circuit
November 25, 2015
Elisabeth A. Shumaker
Clerk of Court
PUBLISH
UNITED STATES COURT OF APPEALS
TENTH CIRCUIT
CHARLES D. LEONE, II,
Plaintiff-Appellant,
v.
No. 14-1185
STEVEN C. OWSLEY; DREW M.
HAYWORTH,
Defendants-Appellees.
Appeal from the United States District Court
for the District of Colorado
(D.C. No. 1:12-CV-02961-PAB-KMT)
Sean Connelly (Tess Hand-Bender with him on the briefs) of Reilly Pozner LLP,
Denver, Colorado, for Plaintiff-Appellant.
Shannon Wells Stevenson (Brett C. Painter and Nathalie A. Bleuzé with her on
the brief) of Davis Graham & Stubbs LLP, Denver, Colorado, for Defendants-
Appellees.
Before MATHESON, SEYMOUR, and McHUGH, Circuit Judges.
SEYMOUR, Circuit Judge.
In 2012, appellant Charles D. Leone II resigned his position as a principal
of Madison Street Partners, LLC (“MSP”). Pursuant to the terms of MSP’s
Operating Agreement, fellow principals Steven Owsley and Drew Hayworth
elected to buy Leone’s interest in MSP. The agreement required the purchase
price to be set at fair market value, as determined in good faith by MSP’s
managers, Mr. Owsley and Mr. Hayworth (“Managers”). After receiving
valuations from two independent valuation firms, the Managers proposed a
purchase price of $135,850, which Mr. Leone rejected.
Mr. Leone sued the Managers in federal district court, contending the
proposed purchase price was far below market value and asserting claims for
breach of contract and breach of the implied covenant of good faith and fair
dealing. The Managers moved for summary judgment on both claims, arguing
Mr. Leone’s claims were barred by their good faith reliance upon the value set by
the independent valuation firms. The district court granted the motion.
On appeal, Mr. Leone contends (1) the district court misapplied the law
regarding express and implied good faith obligations, (2) the court also held,
incorrectly, that bad faith requires a tortious state of mind, and (3) he presented
sufficient evidence of bad faith to survive summary judgment. We conclude the
district court erred in granting summary judgment. Accordingly we REVERSE
and REMAND for further proceedings.
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I
MSP, a Delaware limited liability company with its principal place of
business in Denver, is a registered investment advisor that manages hedge funds.
MSP is compensated for this service in two manners: First, it charges fixed fees
on the “Assets Under Management” or “AUM.” Aplt. App. at 448. Second, it
earns incentive fees based on the performance of those assets. Id. 1
At all times relevant to this dispute, MSP was governed by an Operating
Agreement. The original members of MSP were Mssrs. Leone, Owsley,
Hayworth, Christopher J. Rule, John Elway, and an LLC. Mssrs. Leone, Owsley,
Hayworth and Rule were principals and Mssrs. Owsley and Hayworth were the
firm Managers. Mr. Leone held a 19.75% interest in MSP. Pursuant to its terms,
the Operating Agreement is governed by Delaware law.
When a member’s status as a principal terminates, the Operating Agreement
gives MSP the right, but not the obligation, to acquire the member’s interest in
whole or in part. If MSP opts not to purchase the interest, the other members may
elect to do so at a repurchase price “equal to the amount that the owner of the
[interest] would receive if the assets of [MSP] were sold for their fair market
value, as determined in good faith by the Managers . . . and the proceeds of the
1
Mr. Leone has not challenged the district court’s recitation of facts in its
order granting summary judgment. Accordingly, we rely primarily on that order
in summarizing the facts of this case.
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sale were distributed to the Members.” Id. at 537 (emphasis added) (citing Art.
10, Sec. 10.2(d) of the Operating Agreement). The Operating Agreement does not
further define the process for valuing a member’s interest.
Troubled by alleged mismanagement of MSP, Mr. Leone tendered his
resignation on August 2, 2012. Mr. Owsley and Mr. Hayworth, acting in their
capacity as Managers, elected not to exercise MSP’s option to repurchase Mr.
Leone’s interest. Instead, they exercised their option as members to repurchase
the interest. Under the Operating Agreement, they were responsible as Managers
for determining the repurchase price.
The Managers hired two independent valuation firms: St. Charles Capital,
LLC (“St. Charles”) and INTRINSIC (collectively “the Valuation Firms”), having
had no previous relationship with either firm. The Managers provided all
documents and information the firms requested. Mr. Leone does not contend the
firms were unqualified to value a company such as MSP.
In 2009, Duff & Phelps had performed a valuation of MSP, but that
valuation was not intended for use in determining the fair market value of a
member’s interest. The Duff & Phelps report valued MSP at between $50-$65
million. The Managers were reluctant to give the Duff & Phelps report to the
Valuation Firms and, after they did, argued that the report was not relevant. The
Valuation Firms were aware of the Duff & Phelps report at the time they
conducted their analysis.
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The Managers told the Valuation Firms that a partner was leaving MSP, the
situation was not amicable, there was a high probability of conflict or dispute, and
the report was intended to serve as a tool in the context of a negotiation. They
portrayed MSP as financially struggling. Although MSP had been in business for
about eight years and had no debt, its AUM had declined from $405 million in
September 2008 to $150 million in 2012. The Managers told St. Charles one
reason the AUM had declined was that Mr. Leone took business from MSP when
he left. A reasonable jury could infer this statement was untrue. While Mr.
Leone and his parents had withdrawn their money from MSP funds, an amount
totaling almost $1 million, Mr. Leone did not take clients with him when he left
MSP. Mr. Owsley told INTRINSIC that Mr. Leone’s departure from the firm had
been an “adverse development” because he was “pretty involved in the day-to-day
operations” and it was “just another negative signal to the market that things
weren’t going right.” Id. at 456.
The Managers told the Valuation Firms to consider the poor performance of
other small hedge funds in the current market. They did not tell the Valuation
Firms that MSP sent monthly newsletters to its clients, nor did they provide
copies of the newsletters to the firms. MSP’s July 2012 newsletter, sent just prior
to the valuation, contained detailed information about the performance of its
investment funds and stated MSP’s portfolio had posted a net gain of 2.65% since
the start of the month. It also stated MSP anticipated a “very choppy and volatile
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investment climate for the balance of the year,” but it did not indicate that MSP
was “struggling.” Id.
St. Charles’ valuation report was based on the information MSP provided,
publicly available information, and its expert assessment of MSP’s likely future
performance. The report assumed total revenue for 2011 of $5.892 million and
total net income of $2.21 million. In contrast, MSP’s internal profit and loss
statement listed total revenue of $7.289 million and a net income of $3.398
million.
INTRINSIC was instructed to perform a calculation report, a rougher
financial assessment which did not provide an opinion of the value of MSP.
INTRINSIC’s first draft of the calculation report was based on a 10-year time
frame. After reviewing the draft, Mr. Owsley told INTRINSIC he was not certain
MSP would be around for more than two years and instructed the firm to use a
two-year time frame. Mr. Owsley also told INTRINSIC to take into account only
incentive fees and to disregard management fees. Additionally, INTRINSIC
provided the Managers an electronic spreadsheet that allowed them to plug in
different numbers for relevant variables to demonstrate how changing the
variables would alter the calculated value of the company.
The Valuation Firms reached similar conclusions: St. Charles valued Mr.
Leone’s interest in MSP as of August 10, 2012, in the range of $126,400 to
$158,000; INTRINSIC valued it in the range of $109,000 to $150,000. The
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Managers set the repurchase price at $135,850, the average of the midpoints of
the two ranges.
In the fall of 2012, Mr. Leone’s expert witness, Mitchell Hoffman,
performed an initial calculation valuing Mr. Leone’s interest in MSP as of August
2012 at $1.5 million. Later, after reviewing MSP’s financials, he prepared a
report concluding Mr. Leone’s interest was worth $2.1 million. Robert Shields, a
professional securities trader who had previously worked with Mr. Hayworth,
testified in his deposition that, “based on his knowledge of MSP’s ‘returns since
they opened,’ assets under management, and the growth of the company, he
believes the buyout price offered to Mr. Leone is ‘just extremely low’ and ‘not
even a realistic ballpark.’” Id. at 458.
On September 11, 2012, shortly after telling the Valuation Firms he did not
believe MSP was doing very well, Mr. Hayworth sent an email telling his father:
“I wish I could buy the stake because for once in a long time the firm is on stable
grounds.” Id. at 458-59. Insider Monkey, an investment publication,
subsequently “published an analysis indicating MSP was in the top 50 out of 400
hedge funds for value-weighted returns in the second and third quarters of 2012.”
Id. at 459. On June 27, 2013, Mr. Leone sent a letter to Mr. Owsley stating he
was part of a consortium willing to pay $1 million to purchase Mr. Owsley’s
50.875% interest in MSP. Mr. Owsley did not respond to the offer. A
performance review released by Hedge Weekly declared that as of October 2013,
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MSP’s investment funds were up 19.18% for the year.
II
In November 2012 Mr. Leone sued the Managers in the District Court of
Colorado, claiming (1) they breached Article 10, Section 10.2(d) of the Operating
Agreement by failing to act in good faith in valuing his interest in MSP, and (2)
they breached the implied covenant of good faith and fair dealing by unreasonably
attempting to force him to sell his interest for a price far below fair market value
and by refusing to produce MSP tax returns and other financial records for the
years 2007 through 2012.
In their Answer, the Managers asserted as an affirmative defense that Mr.
Leone’s claims were barred by their “good faith reliance on advice of one or more
third parties.” Id. at 28, Answer, ¶ 3. On summary judgment, they argued they
were immune from liability under Del. Code Ann. tit. 6, § 18-406, which protects
LLC managers who rely in good faith upon expert reports and opinions.
Mr. Leone countered that the Managers were not shielded by the Delaware statute
because they relied on valuation figures that were clearly wrong and improperly
influenced the Valuation Firms in an effort to obtain more favorable numbers.
The district court granted the Managers’ motion for summary judgment. As
to Mr. Leone’s first challenge to the immunity defense, it held the Valuation
Firms were undisputedly qualified to provide expert reports and there was no
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evidence the Managers blindly relied on those reports. With respect to Mr.
Leone’s second challenge to the immunity defense, the district court concluded he
had failed to raise a genuine dispute of material fact as to the procedural integrity
of the valuation. The court also rejected Mr. Leone’s argument that the Managers
acted in bad faith when they refused to turn over MSP’s financial records.
III
We review de novo the district court’s grant of summary judgment to
determine whether any disputed material facts exist and, if not, whether the
Managers were entitled to judgment as a matter of law. Fed. R. Civ. P. 56(a);
Mid-Continent Cas. Co. v. True Oil Co., 767 F.3d 1000, 1004 (10th Cir. 2014).
At summary judgment, the moving party carries the initial burden of
demonstrating a lack of genuine issue of material fact, which it may satisfy by
showing “an absence of evidence to support the nonmoving party’s case.”
Schneider v. City of Grand Junction Police Dept., 717 F.3d 760, 767 (10th Cir.
2013). Thereafter, the burden shifts to the nonmoving party “to set forth specific
facts showing that there is a genuine issue for trial.” Id.We view facts in the light most favorable to the non-moving party and
“draw all reasonable inferences in [his] favor.” Tabor v. Hilti, Inc., 703 F.3d
1206, 1215 (10th Cir. 2013). “A fact is ‘material’ if, under the governing law, it
could have an effect on the outcome of the lawsuit. A dispute over a material fact
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is ‘genuine’ if a rational jury could find in favor of the nonmoving party on the
evidence presented.” Id. (citation omitted).
The Managers moved for summary judgment based on their safe-harbor
affirmative defense for which they carry the burden at trial. “Summary judgment
in favor of the party with the burden of persuasion . . . is inappropriate when the
evidence is susceptible of different interpretations or inferences by the trier of
fact.” Hunt v. Cromartie, 526 U.S. 541, 553 (1999). Significantly for the instant
case, “where the moving party has the burden [of proof]–the plaintiff on a claim
for relief or the defendant on an affirmative defense–his showing must be
sufficient for the court to hold that no reasonable trier of fact could find other
than for the moving party.” Calderone v. United States, 799 F.2d 254, 259 (6th
Cir. 1986) (quoting Schwartzer, Summary Judgment Under the Federal Rules:
Defining Genuine Issues of Material Fact, 99 F.R.D. 465, 487-88 (1984)
(emphasis in original). See also Fontenot v. Upjohn Co., 780 F.2d 1190, 1194
(5th Cir. 1986) (“[I]f the movant bears the burden of proof on an issue, either
because he is the plaintiff or as a defendant he is asserting an affirmative defense,
he must establish beyond peradventure all of the essential elements of the claim
or defense to warrant judgment in his favor.”) (emphasis in original); Rich v.
Sec’y, Fla. Dep’t of Corr., 716 F.3d 525, 530 (11th Cir. 2013) (“When the moving
party has the burden of proof at trial, that party must show affirmatively the
absence of a genuine issue of material fact: it must support its motion with
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credible evidence that would entitle it to a directed verdict if not controverted at
trial.”) (emphasis in original) (quotation marks and citation omitted); Smith v.
Ozmint, 578 F.3d 246, 250 (4th Cir. 2009) (“As to those elements on which it
bears the burden of proof, a [movant] is only entitled to summary judgment if the
proffered evidence is such that a rational factfinder could only find for the
[movant].” (citation omitted)); Torres Vargas v. Santiago Cummings, 149 F.3d
29, 35-36 (1st Cir. 1988) (“The party who has the burden of proof on a dispositive
issue cannot attain summary judgment unless the evidence that he provides on
that issue is conclusive.” (citing Calderone, 799 F.2d at 258)). “In other words,
the evidence in the movant’s favor must be so powerful that no reasonable jury
would be free to disbelieve it. Anything less should result in denial of summary
judgment.” 11 Moore’s Federal Practice, § 56.40[1][c] (Matthew Bender 3d Ed.
2015).
IV
Mr. Leone contends the district court erred as a matter of Delaware law by
(1) conflating express and implied contractual obligations of good faith, (2)
holding that bad faith requires a tortious state of mind, and (3) “refusing to
consider the substantive unreasonableness of the paltry price for buying out an
interest that had generated $2.6 million profits in just the prior four years.”
Opening Br. of Aplt. at 12. He argues further that even if the district court’s
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interpretation of Delaware law was correct, it erred in granting summary
judgment because he presented evidence sufficient to create a genuine issue of
fact about whether the Managers acted in bad faith. 2
A. Whether the District Court Correctly Interpreted Delaware Law
1. Treatment of the Express and Implied Good Faith Covenants
Mr. Leone asserted two causes of action: breach of the Operating
Agreement’s express requirement that the valuation of his interest be performed
in good faith, and breach of an implied covenant of good faith. The Managers
invoked as an affirmative defense Delaware’s safe harbor statute, Del. Code Ann.
tit. 6, § 18-406, claiming they were immune from liability because they relied in
good faith upon the valuation reports of St. Charles and INTRINSIC. Mr. Leone
contended the Managers were not protected by that statute because they acted in
bad faith by relying on valuation figures that were clearly wrong and by
improperly influencing the Valuation Firms in order to obtain a more favorable
number.
In granting summary judgment, the district court did not distinguish
between Mr. Leone’s claim for breach of the express covenant of good faith and
his claim for breach of the implied covenant of good faith. Mr. Leone contends
2
Mr. Leone did not appeal the district court’s grant of summary judgment
against him on his claim that the Managers breached the implied duty of good
faith by refusing to provide MSP’s financial documents to him.
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this was a reversible error because the temporal focus of the covenants differs.
He relies principally on Gerber v. Enterprise Products Holdings, LLC, 67 A.3d
400 (Del. 2013), overruled on other grounds by Winshall v. Viacom Int’l, Inc., 76
A.3d 808 (Del. 2013), in support of this argument.
In Gerber, the plaintiff, who owned limited partnership units, brought a
class action against the limited partnership and its directors challenging sale of a
portion of the partnership and its subsequent merger into a wholly-owned
subsidiary of the purchaser. The limited partnership agreement (“LPA”) provided
that as long as the general partners relied on an expert opinion in making such a
decision, good faith would be conclusively presumed. Id. at 410-11. In contrast,
the implied covenant of good faith asks “what the parties would have agreed to
themselves had they considered the issue in their original bargaining positions at
the time of contracting.” Id. at 418 (quoting ASB Allegiance Real Estate Fund v.
Scion Breckenridge Managing Member, LLC, 50 A.3d 434, 440-42 (Del. Ch.
2012), aff’d in part, rev’d in part on other grounds, 68 A.3d 665 (Del. 2013)).
The Delaware Supreme Court, observing that “the LPA’s contractual fiduciary
duty describes a concept of ‘good faith’ very different from the good faith
concept addressed by the implied covenant,” id. at 418, held the express provision
did not bar a separate claim under the implied covenant of good faith. Id. at 419-
20. To hold otherwise, the court reasoned, would lead to nonsensical results,
particularly in cases “where the general partner’s actions in obtaining a fairness
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opinion from a qualified financial advisor themselves would be arbitrary or
unreasonable, and thereby frustrat[e] the fruits of the bargain that the asserting
party reasonably expected.” Id. at 420 (quotation marks and citation omitted).
The court described hypothetical examples of such conduct, including a qualified
financial advisor opining that a transaction was fair even though, unknown to the
advisor, “the controller had intentionally concealed material information that, if
disclosed, would require the advisor to opine that the transaction price was in fact
not fair.” Id. at 420.
The Operating Agreement in this case required the Managers to set the fair
market value of MSP “in good faith,” but it neither defined the term nor
established conditions under which good faith would be conclusively presumed.
This case is therefore more like DV Realty Advisors LLC v. Policemen’s Annuity
& Benefit Fund of Chicago, 75 A.3d 101, 107 (Del. 2013), where the LPA had an
undefined good faith requirement. 3 There the LPA permitted removal of the
general partners if the limited partners “in good faith determine that such removal
is necessary for the best interests of the partnership.” Id. (emphasis in original).
The court defined contractual good faith as follows:
3
DV Realty Advisors LLC, is part of a series of Delaware Supreme Court
cases interpreting the various nuanced “good faith” clauses in LPAs, of which
Gerber was one. The other cases are SIGA Techs., Inc. v. Permathene, Inc., 67
A.3d 330 (Del. 2013); Norton v. K-Sea Transp. Partners L.P., 67 A.3d 354 (Del.
2013); Brinckerhoff v. Enbridge Energy Co., Inc., 67 A.3d 369 (Del. 2013); and
Allen v. Encore Energy Partners, L.P., 72 A.3d 93 (Del. 2013).
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In our recent opinion in Brinckerhoff v. Enbridge Energy Company,
Inc., we defined the characteristic of good faith by its opposite
characteristic—bad faith. We applied a traditional common law
definition of the business judgment rule to define a limited
partnership agreement’s good faith requirement. We used the
formula describing conduct that falls outside business judgment
protection, namely, an action “so far beyond the bounds of
reasonable judgment that it seems essentially inexplicable on any
ground other than bad faith.” That definition of good faith, as set
forth in Brinckerhoff, is appropriately applied in this case as well.
Id. at 110.
Although the district court here did not differentiate between the express
and implied covenants, inquiry into the temporal focus of each would appear to
yield similar conclusions in the present case. Focusing on the implied covenant,
at the time the parties entered into the Operating Agreement they clearly would
have expected a “good faith” valuation of their ownership interests would require
the Managers to refrain from taking action that would result in an unreasonably
low figure. Focusing on the express contractual provision, one would expect the
same fidelity at the time of the valuation.
Nor does the statutory safe harbor provision affect the “good faith”
analysis. The statute provides that managers of limited liability companies
shall be fully protected in relying in good faith . . . upon information,
opinions, reports or statements presented . . . by any . . other person
as to matters the . . . manager . . . reasonably believes are within such
other person’s professional or expert competence, including
information, opinions, reports or statements as to the value and
amount of the assets, liabilities, profits or losses of the limited
liability company.
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Del. Code Ann. tit. 6, § 18-406. This language is substantially similar to section
14(c) of the Delaware General Corporation Law which the Delaware Supreme
Court interpreted in Brehm v. Eisner, 746 A.2d 244, 261 & n.51 (Del. 2000), as
providing a rebuttable presumption of good faith where the decision maker relies
on an outside expert.
2. Definition of Bad Faith
Mr. Leone argues the district court erroneously held that bad faith requires
“a party’s tortious state of mind” such as “moral obliquity, a furtive design or ill
will.” See Aplt. Opening Br. at 14. The court did, in fact, state: “‘Bad faith is
not simply bad judgment or negligence, but rather it implies the conscious doing
of a wrong because of dishonest purpose or moral obliquity; it is different from
the negative idea of negligence in that it contemplates a state of mind
affirmatively operating with furtive design or ill will.’” Aplt. App. at 463 (citing
SIGA Techs., Inc. v. PharmAthene, Inc., 67 A.3d 330, 346 (Del. 2013)). The
district court’s description of “bad faith” was more expansive than this, however.
Citing the Restatement (Second) of Contracts § 205(d), the court stated: “Bad
faith may be characterized by ‘evasion of the spirit of the bargain, lack of
diligence and slacking off, willful rendering of imperfect performance, [o]r abuse
of power to specify terms.’” Aplt. App. at 463. And it acknowledged aggrieved
plaintiffs can defeat the rebuttable presumption of good faith in the statutory safe
harbor provision by showing:
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(a) the directors did not in fact rely on the expert; (b) their reliance
was not in good faith; (c) they did not reasonably believe that the
expert’s advice was within the expert’s professional competence; (d)
the expert was not selected with reasonable care by or on behalf of
the corporation, and the faulty selection process was attributable to
the directors; (e) the subject matter . . . that was material and
reasonably available was so obvious that the board’s failure to
consider it was grossly negligent regardless of the expert’s advice or
lack of advice; or (f) [] the decision of the Board was so
unconscionable as to constitute waste or fraud.
Aplt. App. at 463-64 (citing Brehm, 746 A.2d at 262). Not only does this list
include conduct that does not necessarily require “moral obliquity,” “furtive
design,” or “ill will,” it also appears to adopt the same temporal focus as the
contractual good faith obligation.
Moreover, the district court concluded that in situations where the parties
have contractually agreed to be bound by an appraiser’s judgment, a party can
successfully challenge the appraisal by showing
the appraised market value resulted from a concerted course of bad
faith action between the appraiser and the other party–i.e., a breach
of contract by a party–or that the appraiser’s result was otherwise
tainted by the contractually improper conduct of the other party
(such as intentionally providing the appraiser with false information
to taint the valuation).
Id. at 464 (citing Senior Hous. Capital, LLC v. SHP Senior Hous. Fund, LLC,
2013 WL 1955012, at *3 (Del. Ch. May 13, 2013) (unpublished) (emphasis
added)). And the district court acknowledged a litany of contested facts which
support Mr. Leone’s contention that the Managers (1) took action to influence the
valuations of his interest and (2) did not actually believe the valuations reflected
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the fair market value of his interest.
Accordingly, we conclude the district court properly articulated the
requirements under Delaware law for a finding of “bad faith” on the part of the
Managers.
3. Consideration of Substantive Accuracy of Repurchase Price
As noted, Mr. Leone contended Delaware’s safe harbor provision does not
immunize the Managers because they acted in bad faith by relying on valuation
figures that were clearly erroneous and by wrongfully influencing the Valuation
Firms in order to obtain a lower valuation. The district court declined to consider
the reasonableness of the proposed repurchase price, ruling that unless Mr. Leone
could show “a concerted course of action between the appraiser and the other
party” or “that the appraiser’s result was otherwise tainted by the contractually
improper conduct of the other party (such as intentionally providing the appraiser
with false information to taint the valuation), the parties are stuck with what they
bargained for.” Aplt. App. at 464-65 (quoting Senior Hous., 2013 WL 1955012,
at *3). As discussed in detail in section B below, the district court concluded that
it “should be guided by Senior Housing [] and refrain from considering the
substantive accuracy of the experts’ conclusions absent evidence of procedural
wrongdoing,” id. at 469, and then held that no reasonable juror could believe the
Managers did anything that affected the procedural integrity of the valuations.
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Citing Allen v. Encore Energy Partners, L.P., 72 A.3d 93 (Del. 2013), Mr.
Leone asserts that the valuation results were so egregiously unreasonable the
court should have considered them as an indicator of bad faith. In Allen, the
parties’ LPA imposed a duty on the general partner to make decisions concerning
the partnership in “good faith,” which the LPA defined as a “belie[f] that the
determination or other action is in the best interests of the Partnership.” Id. at
101. The plaintiff, a limited partner, filed a class action suit in the Court of
Chancery against the general partner, its controller, and its board of directors
challenging the merger of the limited partnership with the general partner’s
controller. Id. at 95. The Managers filed a motion to dismiss, which the Vice
Chancellor granted. Id. On appeal, the Delaware Supreme Court affirmed the
lower court’s dismissal of the complaint on the ground that it failed to state a
claim for breach of the LPA’s contractual duty of good faith. Id. In discussing
the requisites of plaintiff’s claim, the court held that “the ultimate inquiry must
focus on the subjective belief of the specific directors accused of wrongful
conduct,” but it acknowledged “[s]ome actions may objectively be so egregiously
unreasonable, however, that they ‘seem [] essentially inexplicable on any ground
other than [subjective] bad faith.’” Id. at 107 (second and third alterations in
original).
We have found no subsequent Delaware decisions which adopt the analysis
applied in Senior Housing. We need not decide whether Senior Housing (a
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non-precedential opinion) is correct on this point, however, because we take issue
with the district court’s application of the principle to the facts in this case.
As discussed in the next section, the Managers failed to satisfy their burden
of demonstrating they relied in good faith on the Valuation Firms because genuine
disputes of material fact exist as to their conduct relating to the valuation process
as well as the valuation result itself. When considered cumulatively and in the
light most favorable to Mr. Leone, a reasonable jury could infer that the Managers
did not rely in good faith on the Valuation Firms.
B. The District Court Erred in Ruling Mr. Leone’s Evidence Was
Insufficient to Demonstrate Breach of Good Faith
Mr. Leone contends that even if the district court did not misapply
Delaware law, it erred in granting summary judgment against him on his claim for
breach of the implied covenant of good faith. Specifically, he points to (1)
evidence of the Managers’ lies to the Valuation Firms, (2) St. Charles’ use of
financial numbers lower than MSP’s internal numbers, 4 (3) the Managers’
misleadingly negative portrayal of MSP’s financial future and (4) the Valuation
Firms’ reliance on the Managers’ misleading characterizations, all of which Mr.
4
The Managers contend Mr. Leone did not preserve his argument regarding
the discrepancy in financial numbers. They assert, correctly, that he raised the
issue for the first time in his Supplemental Brief in Opposition to Defendants’
Motion for Summary Judgment. But the Managers responded to the argument in
their Supplemental Reply Brief, and the district court specifically addressed the
merits of Mr. Leone’s argument in its order granting summary judgment in favor
of the Managers. We therefore address it.
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Leone asserts were sufficient for his bad faith claim to survive summary
judgment.
Drawing all reasonable inferences in favor of Mr. Leone, the district court
determined that a reasonable juror could conclude: (1) the Managers told the
Valuation Firms Mr. Leone’s departure was not amicable and they needed a
valuation figure to facilitate a negotiation; (2) the Managers wanted to terminate
Mr. Leone’s employment before he resigned and, because of his resignation letter,
had negative feelings toward him at the time the valuations were conducted; (3)
the Managers are financially sophisticated and understood MSP’s value as a
company; (4) the Managers characterized MSP as struggling, in part because of a
decline in AUM, and suggested the company would not be around for more than
two years; (5) the Managers told St. Charles that Mr. Leone took part of their
book of business when he left, even though he did not take any clients; (6) the
Managers intentionally withheld the investor newsletters from the Valuation
Firms; (7) St. Charles used lower numbers for MSP’s revenue and income than
those listed on MSP’s internal profit and loss statements; (8) the Managers were
reluctant to produce the Duff & Phelps report to the Valuation Firms and argued
that it was not relevant after they produced it; (9) in September 2012,
Mr. Hayworth sent an email to his father stating he wished he could purchase
plaintiff’s stake himself because MSP was finally on stable ground; (10) Mr.
Owsley declined to sell his stake in MSP for $1 million; (11) the Managers
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refused to provide “updated financials” to Mr. Leone; and (12) MSP’s funds have
gone up since August 2012. Id. at 470-71.
Nonetheless, the district court held that the evidence and the reasonable
inferences drawn from it were insufficient to demonstrate the Managers acted in
bad faith. It stated, “As a general matter, the testimony of the individuals who
conducted the valuations in this case does not indicate improper interference on
the defendants’ part.” Id. at 472-73. Further, it found the inferences identified
above raised no genuine issues of material fact. Id. at 472. Specifically, the
court concluded the Managers’ statements that the situation was not amicable and
that they needed a number to facilitate negotiations did not rise to the level of
improperly pressuring the firms. It also concluded that although the Managers’
anger toward Mr. Leone and their financial savvy “provide circumstantial
evidence of motive and means, . . . [i]t is important to note that [these conditions]
were contemplated by the Operating Agreement, which gives the managing
partners the right to force the sale of a departing member’s stake at a price to be
determined solely by the managing partners.” Id. at 473.
As to the fact that the Managers painted an unrealistic “doom and gloom”
picture of MSP’s financial health, the court said:
There is . . . no evidence that defendants gave St. Charles any false
information with respect to MSP’s performance, that St. Charles was
unaware of the facts that plaintiff cites in support of his contention
that MSP was doing well, or that defendants required St. Charles to
adopt inaccurate or unreasonable assumptions.
-22-
Id. at 474-75. The court stated further:
The only admissible evidence plaintiff offers in support of his
contention that defendants did not believe that the company was
struggling is Mr. Hayworth’s email and Mr. Owsley’s failure to reply
to the consortium’s offer to buy his stake in the company. However,
as noted earlier, the fact that defendants had a motive to undervalue
plaintiff’s ownership in MSP does not constitute relevant evidence
that defendants did undervalue plaintiff’s stake.
Id. at 475.
Although the district court acknowledged a reasonable juror could infer the
Managers “lied about plaintiff taking business with him,” it concluded that “it is
not reasonable to infer that this lie materially impacted St. Charles’ report.” Id. at
473. As to the inference that Managers intentionally withheld investor
newsletters, the district court stated, “there is no evidence that the information
contained in the newsletters was relevant to valuation of MSP as opposed to
valuation of the assets being managed or that such information was not available
in the other financial documents that defendants provided.” Id. at 474. As to the
fact that St. Charles used lower numbers for MSP’s revenue and income than
those listed on MSP’s internal profit and loss statements, the court said that “there
is no evidence that this discrepancy was improper or that St. Charles should have
relied on different documents, such as MSP’s tax returns.” Id. at 473-74.
With respect to the inferences regarding Mr. Hayworth’s email to his father
and Mr. Owsley’s refusal to sell his interest to Mr. Leone, the court
acknowledged this was “admissible evidence . . . that defendants did not believe
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that the company was struggling,” but reiterated its view that “the fact that
defendants had a motive to undervalue plaintiff’s ownership in MSP does not
constitute relevant evidence that defendants did undervalue plaintiff’s stake.” Id.
at 475. Finally, the court rejected Mr. Leone’s argument that the figures
discussed in the Hedge Weekly performance review meant his 19.75% stake
would have generated him $500,000 to $700,000 alone. The court stated,
“Plaintiff does not provide any evidentiary support for his calculation of
anticipated incentive fees.” Id. at 475.
The district court held Mr. Leone’s evidence was “not sufficient to permit a
reasonable juror to infer that defendants engaged in the ‘conscious doing of a
wrong because of dishonest purpose, or moral obliquity.’” Id. at 471 (citing SIGA
Techs., 67 A.3d at 346). It determined there was no evidence the Managers
provided material misinformation or withheld material information from St.
Charles, pressured St. Charles to arrive at a particular result, presented MSP in a
light they believed to be false, or imposed unreasonable assumptions on the firm’s
calculations. It concluded, “plaintiff has failed to raise a genuine dispute of
material fact as to the procedural integrity of the valuation and, accordingly, the
Court will not entertain a substantive review of the financial calculations
performed.” Id.
The district court’s conclusions are troubling in a number of respects,
including the fact that the court drew inferences in favor of the Managers rather
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than plaintiff. First, a reasonable jury could infer that the Managers engaged in
“the conscious doing of a wrong because of dishonest purpose or moral
obliquity,” SIGA Techs., 67 A.3d at 346, when they told St. Charles that Mr.
Leone took business with him when he left MSP. The court brushed off the
significance of the Managers’ comment, stating that even if they jury inferred the
comment was a lie, it was “not reasonable to infer that this lie materially
impacted St. Charles’ report.” Id. at 473. But the basis for the district court’s
conclusion appears to be the testimony of the Valuation Firms’ personnel that
their valuations were not influenced by the Managers’ statements or conduct. A
reasonable jury could conclude otherwise.
The district court relied primarily on the St. Charles report to support its
conclusion because the INTRINSIC report was not actually a valuation report but
a “calculation” report. See id. at 471 n.10 (“[T]he Court will focus its analysis
primarily on whether the St. Charles report was commissioned and relied on in
good faith.”). The record is replete with evidence the St. Charles report relied
heavily on the Managers’ input in its preparation. For example, Adam Fiedor, the
St. Charles employee in charge of the valuation, testified that in its financial
forecast St. Charles, acting “as per [MSP] management,” deducted the 20 percent
incentive fees partners would ordinarily receive because majority funds were
below the high water mark “and we thought it would take them a year or two to
get back.” Id. at 213, Fiedor dep. at 46:7-47:23. The day St. Charles sent the
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Managers the first draft of the report, they contacted Mr. Fiedor and “called [his]
attention to the continuing decline in the company,” advising him that additional
redemptions had lowered the AUM number, “[w]hich was a major part of our
valuation.” Id. at 215, Fiedor dep. at 54:15-56:10. The “situational overview”
section of the draft report was based largely on input from the Managers. For
example, after reviewing the initial draft of the St. Charles report, the Managers
told Mr. Fiedor to assume a third-party investor or acquirer would not attribute
value to a member’s equity interest because “the partners’ capitals have no
incentive fee or management fee,” which resulted in further adjustment of the
valuation. Id. at 216, Fiedor dep. at 61:24-62:21. The statement in the situational
overview that “[a]long with the majority of smaller hedge funds, management is
experiencing a challenging operating environment for raising investor funds” was
included after the Managers called this point to Mr. Fiedor’s attention. Id. at 216,
Fiedor dep. at 62:22-63:3, 63:18-25. Similarly, the statement in the situational
overview that “[m]anagement expect the company to operate at break-even for
several years,” was based on input from the Managers. Id. at 217, Fiedor dep. at
64:25-66:2. Mr. Fiedor confirmed that the Managers told him they did not
believe the company was going to break even those years. Id. at 217, Fiedor dep.
at 66:11-14. Mr. Fiedor never asked for, nor was he provided, the AUM or “any
financial data for prior to 2009.” Id. at 213-14, Fiedor dep. at 48:13-49:8.
Second, the court held there was sufficient evidence for a reasonable juror
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to conclude the Managers painted an unrealistically grim picture of MSP’s
financial health, but found there was no evidence the Managers gave St. Charles
false information with respect to MSP’s performance. Yet the narrative portion of
the St. Charles report parrots the Managers’ pessimistic forecasts, and the revenue
and income numbers in the report are lower than MSP’s internal revenue and
income numbers. Based on this, a reasonable juror could conclude the Managers’
conduct “deprived the appraiser’s work of contractual integrity,” thus compelling
an inquiry into the substantive fairness of the evaluation. See Senior Housing,
2013 WL 1955012 at *26. Without an inquiry into the substantive fairness of the
valuation, how can it be said with any level of confidence the pessimistic
prediction did not taint the appraisers’ work?
Similarly, the district court held Mr. Hayworth’s email to his father and Mr.
Owsley’s refusal to sell his interest to Mr. Leone constituted admissible evidence
that the Managers did not believe the company was struggling, but it dismissed the
evidence because “the fact that defendants had a motive to undervalue plaintiff’s
ownership in MSP does not constitute relevant evidence that defendants did
undervalue plaintiff’s stake.” Aplt. App. at 475. But without investigating the
reasonableness of the valuation figures, how can the court conclude plaintiff’s
stake was not undervalued? Moreover, based on the Managers’ conduct, a
reasonable juror could conclude that the Managers did not believe the Valuation
Firms’ numbers and that their reliance on them was therefore in bad faith.
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As previously noted, three different types of “good faith” were at play in
this case: the express contractual provision, an implied covenant of good faith, and
the statutory safe harbor for good faith reliance on experts’ opinions. Regardless
of which one applies, the Managers bore the burden as movants for summary
judgment to establish there were no genuine issues of material fact with respect to
their defense of good faith reliance on outside valuations. Although the Managers
are entitled to a rebuttable presumption of good faith in relying on the outside
valuations, Mr. Leone has raised genuine issues of material fact to rebut that
presumption. Without the presumption and given the existence of fact issues
regarding the Managers’ good faith, we conclude the district court erred in
granting summary judgment in favor of the Managers on their affirmative defense.
V
We REVERSE the decision of the district court and REMAND for further
proceedings consistent with this opinion.
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